CREDIT ANALYSIS Selected risk ratios are presented for 2012, 2011 and 2010 for T

Question

CREDIT ANALYSIS Selected risk ratios are presented for 2012, 2011 and 2010 for Techtron Company. 2010 2012 Current Ratio Quick Ratio Operating Cash Flow to Average Current Liabilities Ratio 19 Days Accounts Receivable (a) Days Inventory (b) Operating Cycle (a + b) Days Ac Total Liabilities to Total Assets Ratio Total Liabilities to Shareholders' Equity Ratio Cash Flow from Operations to Total Liabilities Times interest earned (BENCHMARK > 2) 68 141 49 0.621 1.63 0.242 0.55 0.91 0.1 0.243 9.1 2.3 Required: a. Assess the changes in the short-term liquidity risk of Techtron between 2010 and 2012 and the level of that risk at the end of 2012. b. Assess the changes in the long-term solvency risk of Techtron between 2010 and 2012 and the level of that risk at the end of 2012.

Explanation / Answer

a) Though the current ratio & the quick ratio have been at the same level during the three years, the current ratio is lower at 1.5, when compared with the generally accepted ratio of 2. Further, the OCF/Average CL has deteriorated over the years and is only 19.20% in 2012 as against a high of 55.70% in 2010. The deterioration in the OCF/Average CL ratio should be of concern as it tells that the cash generation from operational activities is becoming sluggish. This is evident from the increase in the ratio of 'Days accounts receivable', which though has initially decreased in 2011. b) The long term solvency ratios of Total liabilities to 'Total assets ratio' and the 'Debt/equity ratio' have improved over the years. In contrast the 'Cash flow from operations to total liabilities' has deteriorated in 2012 and is below the benchmark level. It indicates likely difficulty in redeeming long term debts in future. However, the TIE in 2012 is far above the benchmark and is also higher in the first two years. This indicates a comfortable position as regards interest payments.

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